Introduction
If I agree to buy 50kg of ‘deluxe red apples’ from you, and you deliver Red Delicious while I am expecting Pink Lady, a court has two options. It can interpret the contract so as to establish which type or types of red apple were objectively intended by the sale. Or it can simply apply the contract by categorising the facts: did you deliver apples that are both red and deluxe? That is to say, the court can resolve the problem of linguistic indeterminacy by either interpretation or application.
Much has been written about contract interpretation over recent decades. But remarkably little has been said, by judges or academics, regarding the application of contracts.Footnote 1 This is surprising considering that almost every contract dispute involves application of the contract: the contract terms must be defined and then applied to the facts to determine the dispute. This paper seeks to fill a void in this area. It analyses the nature of contract application by answering three fundamental questions. First, what is the goal in applying a contract? Secondly, how does one apply a contract? Thirdly, when is the process employed in practice?
In answer to the first question, the aim of contract application is to determine whether the components in a contract term are satisfied on the facts. Like legal rules, contract terms are applied by establishing whether the predicates or conditions in the term are met.
As regards the second question, the application of a contract involves categorisation or classification, that is, the process of determining whether a fact or facts fall within a particular class, quality, relation or other category. A contract is applied by categorising or classifying facts so as to determine whether the components in a contract term are met. There are at least three methods of categorisation: by criteria; by factor-balancing; and by analogy or comparison. The appropriate method may depend on the categorisation task at hand. For example, if a class can be defined in terms of positive or negative properties, it may be appropriate to categorise by reference to criteria; if a category is demarked by conflicting indicia rather than criteria, factor-balancing may be suitable; and if the class is simply a description that cannot be deconstructed in terms of criteria or indicia, then one might categorise by analogy.
With respect to the third question, the process of application follows the definition of the term in question and the ascertainment of the facts to which the term is to be applied. However, the categorisation or classification process is rarely engaged in an overt or complex way. A key reason for this is because the application process and the interpretive process both address problems of linguistic indeterminacy, that is, cases where the words of the contract do not fit the facts. And most problems of linguistic indeterminacy are usually resolved through interpretation, that is, by ascertaining the reasonable person’s understanding of what was objectively meant by the words in a contract. The relevant contract term is defined with such specificity that it is clear how it is to be applied to the facts. Ordinarily, it is only when the means to define the rule ‘run out’ that complex reasoning in terms of categorisation or classification is necessary. For example, the contract may refer to a broad normative or evaluative standard (such as reasonableness) or it may contain a subject matter description that cannot be defined in specific terms (eg the description of a chattel in a sale of goods). In these types of cases at least, courts often engage in categorisation or classification in a sophisticated way so as to resolve the problem.
This paper is doctrinal in nature. It is interpretative; it accepts the law as it is. It relies primarily on a review of case law to illustrate and explain the application process in action. However, the paper also utilises theoretical perspectives (both in law and beyond) to frame the doctrinal analysis. Legal jurisprudence, linguistics, philosophy, computer science and informatics are employed, in particular, to preface and explain the different methods of categorisation through which a contract is applied. The focus is the common law of contract as it has developed in England and other common law jurisdictions. The selection of cases analysed is unavoidably random; it is hard to find cases illustrating the application process in action using a systematic method.
One might think that, in a paper exploring how and in what circumstances a contract is applied, you would see a discussion regarding the concept of ‘application’ at the outset. However, the aim of this paper is, in effect, to define application as a judicial technique in the context of contract law.Footnote 2 That is to say, the aim is to define application in terms of why we apply contracts, how we apply contracts, and when we apply contracts. To put it differently, if you are asking ‘what is application’, then my answer is that it is a technique that serves a particular object in a particular way in particular circumstances. It is the process through which one ascertains whether the components of a contract term are met on the facts; it involves a process of categorisation by criteria, by factor-balancing, or by analogy. It can be contrasted with the process of interpretation through which one defines a term as a matter of objective intention and meaning.
The bulk of the analysis in this paper is set out in Sections 2 (the aim in application), 3 (the mechanics of application) and 4 (the scope for application). Before exploring the nature of application in detail, we need to examine what has been said about application and its relationship with interpretation and construction. That is the focus of Section 1, to which we now turn.
1. Construction, interpretation and application: terminology and concepts
Terminology in the common law of contract is notoriously messy. The area of application is no exception. In fact, the role of application in contract law has arguably been obscured by inaccurate language and overlapping labels, in particular, with respect to construction and interpretation. Hence, the aim of this part of this paper is to briefly summarise terminological issues and outline common views regarding application and its place in contract law.
Application is commonly regarded as either part of interpretation or part of construction. For example, in Casson v Ostley PJ Ltd,Footnote 3 Sedley LJ stated: ‘Interpretation … only happens when words are applied to facts’.Footnote 4 That said, it is generally understood that the application of a contract follows the ascertainment of what was meant by the words to be applied.Footnote 5 Hence, McMeel views ‘construction disputes’ as involving two phases: the first ‘concerned with ascertaining the meaning of the contractual language’, and the second involving ‘the application of the rule to be found from the parties’ language to the particular facts or circumstances’.Footnote 6 In similar terms, Carter sees ‘construction’ as consisting of three stages: the preliminary stage (eg identifying background); the meaning stage; and the application stage.Footnote 7 The application process is also often said to be part of, or tied up with, determining the ‘effect’ or ‘legal effect’ of a contract.Footnote 8 For example, Lewison describes ‘interpretation’ as involving ‘the ascertainment of the words used by the parties and the determination, subject to any rule of law, of the legal effect of those words’.Footnote 9 And Lindley LJ remarked in Chatenay v Brazilian Submarine Telegraph Co Ltd:Footnote 10
The expression ‘construction,’ as applied to a document, at all events as used by English lawyers, includes two things: first, the meaning of the words; and, secondly, their legal effect, or the effect which is to be given to them.Footnote 11
Despite the academic recognition that construction involves or necessitates application, leading judgments on interpretation and construction say very little about the application process.Footnote 12 For the most part, the notion that a contract needs to be applied is merely referenced by judges in England and other common law jurisdictions when engaging in the process of application itself.Footnote 13
This paper draws a critical distinction between the process of application and the processes employed to define the terms in a contract.Footnote 14 The key techniques engaged in defining contract terms are interpretation, implication in fact, and common mistake rectification. Under the English common law of contract, interpretation is the process through which one ascertains what was objectively meant or intended by the words in a contract (ie the reasonable person’s understanding of the words);Footnote 15 implication is the process through which one implies a term as a matter of presumed intention based on necessity or obviousness;Footnote 16 and rectification is a technique through which one rectifies a document in equity, in the case of common mistake, to accord with a common intention of the parties at the time of contracting.Footnote 17
The process of application is distinct from these processes, albeit quite closely related. As defined in this paper, application is a technique that is engaged after a term has been defined. It is employed to ascertain whether the components of the term are met on the facts; it involves categorisation or classification.
The term ‘construction’ can be used broadly to encompass both the process of application and the techniques employed to define terms in a contract.Footnote 18 It is often used as an umbrella term to describe how one ascertains the ‘legal effect’ of a contract;Footnote 19 it can denote the ‘holistic’ process of ‘attempting to understand the entire contractual relationship’.Footnote 20 For example, the Supreme Court of the United Kingdom has noted that implication in fact and interpretation, while ‘different processes governed by different rules’,Footnote 21 can be regarded as ‘part of construction of the contract in a broad sense’.Footnote 22
In addition to its use as an umbrella term, the term ‘construction’ is also commonly used interchangeably with ‘interpretation’ to refer to the interpretive process.Footnote 23 In the interests of conceptual clarity, this paper does not use the term in this way. Instead, this paper describes the process of ascertaining what was meant or intended by words in a contract as ‘interpretation’. As already noted, this process is distinct from the process of application. Like interpretation and implication in fact, interpretation and application are ‘different processes governed by different rules’.Footnote 24 Interpretation involves a search for meaning and intention; application involves categorisation and classification. With these definitional and conceptual issues resolved, we can begin our analysis of the nature of application, starting with the aim of the process.
2. The aim in application
The aim of contract application is to determine whether the components of a contract term are met on the facts. Contract terms, like legal rules, can be broken down into constituent components and the process of application is one through which it is determined whether the components are satisfied.
The law in general is often conceptualised in terms of rules that need to be applied.Footnote 25 These rules are typically formulated in logical deductive terms along the lines of ‘if p, then q’. The process of application is one through which it is determined whether the predicate or predicates (p) are satisfied so that the legal consequences (q) follow. As Pollock postulated over a century ago:
Every question of interpretation may be reduced ultimately to this form: Given a rule of law that conditions generically described as A produce a certain legal liability or other consequence X, does the specific fact or group of facts n fall within the genus A. Footnote 26
More recently, MacCormick expressed the idea in similar terms:
[A]ll legal rules … can … be recast in the form that if certain facts and circumstances obtain, a certain legal consequence is to follow … [In] canonical form if p then q (p ⊃ q), the symbol p stands for a proposition stipulating a set of operative facts, q for the legal consequence which is to follow.Footnote 27
Hence, in this sense, the application of a legal rule involves establishing whether the ‘operative facts’ or ‘factual predicate[s]’ in a rule are met; it involves ascertaining whether ‘the factual conditions triggering the application of the rule’ are satisfied.Footnote 28
Like the application of a legal rule, the application of a contract term involves determining whether its components are met. However, what exactly constitutes a ‘term’ of a contract is not entirely clear. For some, contract terms are akin to rules. For example, as has been noted by McMeel, the construction of a contract involves ‘identifying in a document a rule for future cooperative behaviour from the language of the instrument, and then applying that rule to subsequent facts or situations’.Footnote 29 Nonetheless, there is an apparent difficulty with the conceptualisation of contracts in terms of rules because not all contract terms are expressed in logical deductive form; that is to say, they are not all ‘rules’ in the strict deductive sense. Contingent conditions or ‘conditions precedent’ are by nature expressed in deductive logic. Several other types of contractual provisions can also be cast in the form ‘if p, then q’, including exclusions of liability, termination clauses, agreed damages clauses, and so on. Yet many contract terms cannot be expressed in such a way. Some terms are merely statements of intention, such as a statement that the parties intend (or do not intend) an agreement to be binding as a contract.Footnote 30 Most simply take the form of an imperative statement or norm of conduct, such as ‘party A must do X’.Footnote 31 Hence, rather than being framed as rules in the strict deductive sense, contract terms are more accurately understood as simply propositions of law agreed (or taken to be agreed) between the parties – propositions of law that govern the parties’ contractual rights and obligations.Footnote 32 To put it differently, a contract term is a norm of conduct, statement of intention or imperative statement that forms part of the contractual agreement and governs the relationship between the parties.
Whatever the form of a contract term, the process of applying the term still involves determining whether its components are satisfied. Contracts refer to ‘classes of ideas, actions, events, states of affairs, persons, and other things’.Footnote 33 Hence, in applying the contract, one must determine whether these classes are satisfied on the facts; one must establish whether the ‘operative facts’ in a term are met. A classic example is whether a chattel proffered on delivery satisfies a contractual description under a sale or hire contract.Footnote 34 Judges often grapple with these types of problems when seeking to resolve cases on construction. They consider whether a particular clause is ‘engaged’ by the facts,Footnote 35 whether the language is ‘apt’ to ‘encompass’, ‘include’, ‘cover’ or ‘exten[d] to’ particular facts,Footnote 36 whether a ‘reference fits’ a particular object,Footnote 37 whether a particular thing falls ‘within [the] words’,Footnote 38 and so on. What is involved in determining whether the components of a contract term are met on the facts is the focus of the next part of this paper.
3. The mechanics of application
Contract application involves categorising or classifying facts to establish whether the components of a contract term have been satisfied. It turns on the categorisation or classification of facts to determine whether they fall within a particular ‘class’, ‘quality’, ‘relation’ or other category identified in the contract.Footnote 39 It involves ‘“subsum[ing]” particular facts under general classificatory heads’.Footnote 40 For example, one might need to determine: whether particular profits qualify as profits of a corporate group; whether conduct falls within the category of dishonest; whether a given loss amounts to consequential or indirect loss; whether a liability or loss qualifies as being caused by a particular occurrence; and so on. Hence, to borrow from the field of informatics, each instance of contract application involves ‘a set of boxes … into which things [are] put to then do some kind of work’,Footnote 41 the work being the ascertainment of whether the components of a contract term are met.
To understand the mechanics of applying a contract term, we need to understand how judges and lawyers categorise facts as part of the process; we need to understand how one categorises or classifies facts in determining whether a component in a contract term is met. That is the focus of this part of this paper. It analyses cases to illustrate the application process in action. It also borrows from theories of categorisation in other disciplines so as to preface and justify this doctrinal analysis.
There are at least three methods of categorisation in contract application.Footnote 42 First, there is categorisation by reference to constituent properties, that is, categorisation by reference to positive or negative criteria. Secondly, there is categorisation by factor-balancing, that is, categorisation by reference to conflicting indicia. And thirdly, there is categorisation by analogy, that is, categorisation by comparison with past cases or with similar objects that either do or do not fall within the class.
Depending on the nature of the case, one manner of categorisation may be more appropriate than another. For example, if a category is identifiable by positive or negative properties (such as whether or not a machine is in operation),Footnote 43 then categorisation by reference to criteria may be more suitable; if a category is defined not so much by criteria but by conflicting indicia (such as a normative standard like ‘material breach’),Footnote 44 then factor-balancing may be more appropriate; and if the category is simply a description not readily capable of being broken down into criteria or indicia (such as an exclusion of consequential or indirect loss),Footnote 45 then reasoning by analogy can be employed. There is also scope for applying a combined or amalgamated approach.Footnote 46
It could be argued that judges categorise simply as a matter of intuition or impressionFootnote 47 – that classification is part of the ‘mental work that produces impressions [and] intuitions … in silence in our minds’.Footnote 48 However, this explanation appears to be unsatisfactory, particularly considering that contract law seeks to secure commercial certainty,Footnote 49 albeit in a flexible and commercially sensible way.Footnote 50 It may be that, in some cases, judges categorise by reference to underlying biases or preferences.Footnote 51 This reflects the recognition in cognitive science and psychology that how we categorise may depend on moral or political choicesFootnote 52 and that ‘intuitive’ decision-making may turn on underlying biases.Footnote 53 Whether this is an acceptable explanation for the process of categorisation in contract application is debatable. This paper does not adopt a position either way. Instead, it focuses on three methods of categorisation that can be explained in terms of logic and process, namely, categorisation by criteria, factor-balancing, and analogy.
(a) Categorisation by criteria
Perhaps the typical way one would understand categorisation in the application of contracts is that it turns on identifying the constituent properties or components of a class. That is, one establishes the properties or criteria of the components of a contract term and then one determines whether those properties or criteria are established on the facts.
Classification by reference to constituent properties is of course a fundamental cognitive activity. To take a simple example of a small child seeking to slip blocks into a shape-sorter, ‘the infant must distinguish, among the features of the blocks, what matters (shape) and what does not (colour)’.Footnote 54 It is also a critical feature of legal reasoning. Statutes and contracts use definitions to identify the properties or parts of a word or phrase. And the law itself has been taxonomised, with varying degrees of success, by reference to the various properties of different areas of law.Footnote 55 Categorisation by reference to underlying properties has long been advocated by philosophers, including Aristotle, who proposed ten categories for classifying all things that can be the subject or the predicate of a proposition.Footnote 56 Classification based on properties was also embraced by prominent mathematicians and linguists in the late nineteenth and early twentieth centuries. For example, Frege is often credited with formulating the principle of ‘compositionality’, that is, the notion that the meaning of an expression is a function of the meaning of its parts.Footnote 57 Bertrand Russell employed the theory of types to explain numbers.Footnote 58 And Wittgenstein, in his early work, broke down the world in terms of ‘facts’, each of which is made up of ‘objects’ or ‘things’,Footnote 59 with a ‘thing’ only being distinguishable if it ‘has properties which no other has’.Footnote 60
Categorisation by reference to properties is suitable in contract application where the relevant component in a contract term constitutes a class that can be defined by criteria. The criteria can be positive or negative. For example, in Arthur White (Contractors) Ltd v Tarmac Civil Engineering Ltd,Footnote 61 the House of Lords considered whether a hirer of an excavator was liable to indemnify the owner of the excavator for a personal injury claim arising from use of the excavator. The owner supplied a driver to operate the excavator as part of the hire and it was a term of the hire that the hirer was responsible for ‘all claims arising in connection with operation of [the excavator]’ by the driver.Footnote 62 The driver had used the excavator to lift a section of piping and lower it into a deep trench. The driver attached the piping to the excavator bucket and raised it by the boom of the excavator. It was then decided that widening of the trench was necessary. The driver applied the brakes. The piping remained suspended in the air for a few minutes, until the brakes failed and the piping fell, seriously injuring an engineer on site. Among other points, the hirer argued that the excavator was not in ‘operation’ when the injury occurred, and hence the hirer was not responsible for the personal injury claim of the engineer. Lord Morris resolved this question by categorising or classifying the facts to determine whether the relevant component in the term was satisfied, namely, whether the excavator was in ‘operation’. His Lordship ultimately rejected the hirer’s argument, it appears, based on two criteria for what constituted ‘operation of [the excavator]’. The first was positive: the excavator was in ‘operation’ if the engine was running, which it had been during the course of the accident. The second was negative: a mere ‘temporary pause’ did not deny the ‘continuing operation’ of the excavator.Footnote 63
If the court is applying a broad normative standard agreed by the parties, the court may be able to assess whether or not conduct meets the standard by reference to criteria, some of which are established by authority in related areas. The decision of the High Court of Australia in McCann v Switzerland Insurance Australia Ltd Footnote 64 is a useful example. A law firm claimed under its professional indemnity insurance policy with respect to liability for loss of a client’s funds. The money had been deposited for the purpose of purchasing what turned out to be a fictitious financial instrument. The partner who had arranged the transaction believed that the instrument existed, although he had of course never acquired such an instrument in the past. The funds were lost after the partner transferred the money, without security, to another bank for the purpose of purchasing the instrument. Critically, the partner had agreed a secret commission as part of the transaction. The insurer denied indemnity, relying on an exclusion in the policy for liability that was ‘brought about by the dishonest or fraudulent act or omission’ of a partner of the firm. One issue was the extent to which the partner had been dishonest.Footnote 65 Gleeson CJ, Gaudron, Kirby and Hayne JJ held that the partner’s conduct as a whole in the transaction was dishonest,Footnote 66 citing a number of criteria, several of which were substantiated by authority in related areas, namely, criminal law, equity, and professional ethics. The criteria included: conduct is dishonest if it is in breach of fiduciary duty (the partner had preferred his personal interests over those of the client);Footnote 67 conduct is dishonest if it involves the concealment of knowledge or intention in circumstances requiring disclosure (the partner had failed to disclose his intention to make a profit and his lack of knowledge regarding the particular instrument);Footnote 68 a person acts dishonestly if the person uses means to deal with moneys that they know they have no right to use;Footnote 69 conduct is dishonest if it involves ‘pretence and collusion in the conscious misuse of a power’;Footnote 70 and a person acts dishonestly if they make payments in a manner that they know lacked authority.Footnote 71 In essence, the court applied the normative standard of ‘dishonesty’ by identifying criteria for dishonesty (rooted in related areas of law) and then determining whether those criteria were satisfied on the facts. This is a classical approach to classification based on criteria or properties.
(b) Categorisation by factor-balancing
Another way to rationalise categorisation in contract application is that it is a matter of balancing a variety of factors to draw an inference regarding the correct classification in a given case. That is to say, a contract term is applied by weighing and balancing factors to determine whether the components of the term are met on the facts.
On a granular level, factor-balancing involves four steps, although not always explicitly recognised: (i) identify the options being considered; (ii) identify the factors in support of each option; (iii) perform an ‘evaluative assessment’ of each option (ie a determination of ‘how intensely each option deserves to be favoured in light of each factor, relative to other options’); and (iv) determine the ‘relative importance to be accorded to each factor when combining assessments across factors’.Footnote 72 In essence, the process turns on inductive, rather than deductive, logic. In deductive logic, a premise or premises establish an alleged proposition absolutely,Footnote 73 whereas, with inductive reasoning, the premise or premises establish the alleged proposition in terms of likelihood.Footnote 74 In factor-balancing, we use inductive logic to assess the relative strength of each factor and, in turn, to make the relevant determination as a matter of probability.
Factor-balancing is common in legal reasoning. Statutory and doctrinal tests often simply state matters that must be taken into account in reaching a conclusion, leaving the rest of the work to be done through balancing the various factors. For example, in contract law, interpretation,Footnote 75 frustrationFootnote 76 and remotenessFootnote 77 have been conceptualised in terms of factor-balancing. The process is perhaps best exemplified by analysing interpretation. The various factors (ie potential meanings, background, purpose, etc) act as indicators of intention, and the strength of each factor is established through inductive inference; one considers the degree to which each relevant factor reinforces a conclusion regarding what the parties objectively meant by the words in the contract.Footnote 78
Categorisation by factor-balancing is appropriate in contract application where a component in a contract term can be defined by reference to conflicting indicia. For example, whether a charterer of a vessel has breached a warranty that it would only carry between ‘safe’ berths or ports is determined by reference to ‘factors’, including the past history of the relevant port, the frequency (if any) of the event, the degree of foreseeability of the event (or combination of events), and the severity of the event.Footnote 79 Likewise, in determining whether a party has committed a ‘material breach’ giving rise to a power to terminate under an express termination clause, courts take into account a range of factors, such as the nature of the breach, its consequences, the breach in the context of the agreement, the guilty party’s explanation for the breach, and the consequences of holding that the agreement was terminated or that it continues.Footnote 80 That is to say, the court determines whether a component in a contract term is satisfied through weighing and balancing competing factors.
(c) Categorisation by analogy
A simpler alternative in terms of explaining categorisation in contract application is that it involves reasoning by analogy or comparison. In some instances, we determine whether the components of a contract term are satisfied by drawing analogies with comparable cases and objects.
Categorisation by analogy can be understand in a number of ways. On one view, it is essentially a matter of identifying patterns or inferring conclusions from examples. One identifies the same pattern or patterns in a particular object and a class of objects, and thereby categorises the object as falling within the class. Categorisation by pattern recognition is remarkably common in everyday life. Most people do it each day without thinking. It is fundamental to the machine learning algorithms that power many modern applications; through machine learning, a machine is trained to automatically categorise unseen data by recognising patterns in training data.Footnote 81 It is also one way to explain the jurisprudential system of precedent; that is, one ‘treat[s] like cases alike’ by identifying ‘material likeness’.Footnote 82 To put it in terms of logic, categorising by analogy involves ‘using examples in the process of inferring a conclusion from a set of premises’.Footnote 83
Categorisation by analogy can also be understood, in rudimentary terms, as turning on a more simplistic comparison between the facts under consideration and objects that do and do not fall within the relevant class. This is similar to prototype theory, a theory of categorisation in psychology and cognitive science.Footnote 84 The theory arguably derives from Wittgenstein’s work on ‘family resemblance’, which involved categorisation by reference to ‘a complicated network of similarities overlapping and criss-crossing’.Footnote 85 The fundamental idea underpinning prototype theory is that, based on a prototype example of a member of a category, one can reason by gradients in terms of items that fall within the category.Footnote 86 For example, a sparrow may constitute a prototype example of a bird, while an ostrich is at the periphery.Footnote 87 Likewise, to borrow from Hart, a motor-car clearly qualifies as a vehicle while a bicycle does not.Footnote 88 Prototype theory was advanced as a simpler and more accurate rationalisation of how people categorise in real life – one that reflected the fact that we often classify items and objects with less cognitive effort than a properties-based approach suggests.Footnote 89 Glanville Williams described a similar way of ‘controlling words’, namely, by identifying ‘the lower-order referent’ or the ‘real object in which the quality is conceived as inhering’.Footnote 90 Reasoning in this way is particularly appropriate in classifying ‘basic’ objects,Footnote 91 such as colours.Footnote 92
It is appropriate to categorise by analogy in contract application when points of comparison are available. Sometimes judges resort to past cases dealing with similar words and similar facts to identify points of comparison, such as in determining whether an exclusion of consequential or indirect loss captures a particular liability.Footnote 93 But resort to precedent is not strictly necessary. For example, in Thames Valley Power Ltd v Total Gas & Power Ltd,Footnote 94 Christopher Clarke J concluded that a sharp rise in the price of gas did not qualify as ‘force majeure’ under a gas supply agreement (which would automatically discharge the contract). His Honour noted that the facts before him were not the paradigm case of force majeure where a supplier had ‘become unable’ to supply gas. Nor was it a situation where the supplier would be physically unable to supply in future (which was still not sufficient to establish force majeure). Rather, the case was two steps removed from force majeure in that it had simply become ‘uneconomic’ to supply gas. Hence, reasoning by analogy with a paradigm example, there was no force majeure.Footnote 95 One can see similar reasoning at play in the application of express contractual duties to negotiate or otherwise act in good faith, with judges reasoning by reference to typical examples of both good faith (such as honesty)Footnote 96 and bad faithFootnote 97 (eg threatening a breach of contract).Footnote 98 Points of comparison are used to guide the process through which one determines whether a component in a contract term is met. The contract is applied by analogy.Footnote 99
4. The scope for application
The process of categorisation or classification involved in applying a contract is rarely engaged in a complex and overt way. This is partly because the application process is only engaged after one has both ascertained the facts to which the term is to be appliedFootnote 100 and also defined the term itself.Footnote 101 More fundamentally, it is because both the application process and the interpretive process address cases of linguistic indeterminacy, that is, cases where it is not clear how a contract term applies on the facts. And these problems are usually in practice resolved through interpretation. The relevant term is defined with such specificity that application of the contract is rendered straightforward. As a result, the application process is usually only engaged in a meaningful way when it is not possible to define the term precisely. In these cases at least, judges must classify or categorise the facts in detail so as to resolve the dispute. Before turning to these cases, we must analyse the concept of linguistic indeterminacy and why it is that interpretation (and not application) is usually engaged to determine problems of linguistic indeterminacy.
(a) Problems of linguistic indeterminacy
The concept of linguistic indeterminacy can be framed in a number of ways.Footnote 102 For the purpose of this paper, it describes the circumstance where ambiguity or vagueness in contractual language make it unclear how a contract term is to be applied.Footnote 103 In short, linguistic indeterminacy arises when ‘the words fall short of the facts’.Footnote 104 It occurs when ‘the information [provided] is [not] sufficiently specific to answer the question, or questions, directing one’s inquiry’.Footnote 105
Problems of linguistic indeterminacy are remarkably common in law and in contracts. As Hart argued in The Concept of Law, the ‘open texture’ of language means that there will always be ‘hard cases’ at the penumbra of a legal rule.Footnote 106 Glanville Williams also remarked that ‘not merely some but all words are capable of occasioning difficulty in their application’,Footnote 107 citing the following examples:
[I]s an album a ‘book’? Is a bicycle a ‘carriage’? Is a flag a ‘document’? Is a flying-boat a ‘ship or vessel’? Are household goods ‘money’? Is ice-cream ‘meat’? Is sandstone a ‘mineral’? And so on.Footnote 108
Cases on contract are replete with examples of linguistic indeterminacy. For example, the question might be: whether an excavator is in ‘operation’ when it is stationary and the brakes have been applied, yet the engine is running;Footnote 109 whether a dispute as to contract invalidity is caught by an arbitration clause;Footnote 110 whether the insolvency of a shipbuilder triggered a refund guarantee issued in relation to a shipbuilding contract;Footnote 111 whether loss or damage arising from self-reporting regulatory non-compliance falls within the scope of an indemnity in a share sale agreement;Footnote 112 and so on. At least as a matter of principle, these problems can be resolved through either the process of application or the processes engaged to define contract terms, in particular, interpretation.
(b) The resolution of linguistic indeterminacy through interpretation
Interpretation is the process through which one ascertains the reasonable person’s understanding of what was meant by the words in a contract. Problems of linguistic indeterminacy are usually resolved through this process.Footnote 113 The relevant contract term is defined through interpretation so as to ‘mak[e] express provision for the particular difficulty that has arisen’.Footnote 114 The process of application and the process of interpretation remain distinct. It is simply that, in the interpretive process, the term is defined with such specificity that the application process is rendered straightforward.
Beyond the mere fact that a term is interpreted before it is applied, there are at least two reasons why linguistic indeterminacy is usually resolved through interpretation rather than application. The first is that the facts to which the contract is to be applied impact the process of interpretation. In particular, the consequences of competing interpretations are taken into account when interpreting the contract. As Lord Reid famously stated in L Schuler AG v Wickman Machine Tool Sales Ltd:Footnote 115
The fact that a particular construction leads to a very unreasonable result must be a relevant consideration. The more unreasonable the result the more unlikely it is that the parties can have intended it, and if they do intend it the more necessary it is that they shall make that intention abundantly clear.Footnote 116
One must take into account potential consequences in interpreting a contract and one can only establish those consequences by looking at the facts to which the contract is to be applied.Footnote 117 Because the facts of the dispute are before the court in interpreting the contract, the court can address linguistic indeterminacy through interpretation.
The second and most fundamental reason why problems of linguistic indeterminacy are usually resolved through interpretation rather than application is the flexibility inherent in the interpretive process. As Bix remarks in the broader context of legal interpretation, ‘[t]he decision whether a rule applies to a particular situation often turns on the meaning – on delimiting the range of meanings – of a general term’.Footnote 118 Likewise, for MacCormick, ambiguity in a legal rule is effectively determined by ‘choosing between rival versions of the rule’.Footnote 119 Of course, to borrow from Wittgenstein, each ‘interpretation’ of a rule is effectively ‘the substitution of one expression of the rule for another’.Footnote 120 But the legal process of interpretation is typically guided by the reasonable person. Scalia described this as the ‘Fair Reading Method’: ‘determining the application of a governing text to given facts on the basis of how a reasonable reader, fully competent in the language, would have understood the text at the time it was issued’.Footnote 121 Hence, for Scalia, Hart’s classic ‘chestnut’ of whether a bicycle is prohibited in a park by reason of a sign prohibiting ‘vehicles’ is resolved by defining the rule as a matter of interpretation or intention so that it is clear that bicycles are not caught by the rule.Footnote 122
A similar approach applies in the interpretation of a contract. The court arrives at the reasonable person’s understanding of what was meant by the words by considering the meaning of the words, the contract as a whole, the background, the objects served by the contract, and the consequences of the competing interpretations.Footnote 123 But the court does so bearing in mind the facts to which the contract is to be applied. Take the seminal case of Prenn v Simmonds. Footnote 124 Mr Prenn had agreed to sell shares in a company that he had recently acquired, RTT Ltd, to an employee of a subsidiary of that company, Dr Simmonds. The share sale was relevantly conditional upon the ‘aggregate profits of RTT’ exceeding a certain threshold over a four-year period. The difficulty was that, on the facts that transpired, the profits of RTT Ltd did not exceed the threshold, while the profits of the RTT group did exceed the threshold. The House of Lords had to determine whether the share sale condition was satisfied so as to establish whether Dr Simmonds was entitled to an order for specific performance of the contract for sale of the shares. The share sale condition merely referred to the profits of ‘RTT’ without clearly specifying whether the profits needed to be those of RTT Ltd or the RTT group.Footnote 125 Hence, there was a problem of linguistic indeterminacy: did ‘RTT’ encompass only RTT Ltd or did it also extend to the RTT group? The House of Lords determined the case as a matter of interpretation. Properly interpreted, the share sale condition only required that group profits exceed the threshold. By inference drawn from the contract as a whole, the background and the purpose of the transaction, it was clear that the parties, by agreeing the share sale condition, had objectively intended a share sale that was conditional upon group profits exceeding the prescribed amount.Footnote 126 Through interpretation, the lexical ambiguity in the term ‘RTT’ was resolved such that it was apparent, when applying the contract, that the share sale condition was met: group profits clearly exceeded the threshold. The myriad cases on interpretation provide numerous examples of contracts being interpreted so as to resolve linguistic indeterminacy and thereby make it clear how the contract must be applied. To put it plainly, to the extent possible, linguistic indeterminacy is usually in effect addressed through interpretation rather than application, that is, as a matter of objective intention rather than through categorisation or classification.Footnote 127
(c) The resolution of linguistic indeterminacy through application
It becomes necessary to resolve linguistic indeterminacy through application when the means to define a contract term ‘run out’.Footnote 128 That is to say, in some instances, it is not possible to define the term with sufficient specificity such that it is clear how the term should be applied. In at least these cases, one must categorise or classify the facts in detail so as to resolve the dispute. By way of example, categorisation or classification is often necessary in the circumstances outlined below.Footnote 129
The first situation is where a term contains a broad normative or evaluative standard, such as reasonableness, fairness, necessity, and so on.Footnote 130 In rare cases, the contract indicates how the standard is to be met, such as in Electricity Generation Corpn v Woodside Energy Ltd,Footnote 131 where a gas supply contract detailed how a ‘reasonable endeavours’ obligation was to be satisfied. In many cases, however, one must simply ascertain whether the standard has been met without any further guidance drawn from the contract or party intention. For example, in McCann,Footnote 132 the High Court of Australia determined whether particular conduct was ‘dishonest’ (for the purpose of establishing liability under an insurance policy) by reference to criteria for establishing dishonest conduct.Footnote 133
The second circumstance in which one often needs to categorise or classify facts in some detail is where a term contains a subject matter description. After the subject matter has been defined as a matter of interpretation, one must determine whether the description is met on the facts.Footnote 134 In some cases, the subject matter can only be defined in broad terms. This was the case in The Diana Prosperity. Footnote 135 A sub-charter of an unbuilt vessel described the vessel by reference to a particular yard or hull number. However, the vessel delivered was built at a different yard from that specified in the sub-charter. The sub-charter was ultimately interpreted such that the vessel merely needed to be identifiable as being built at the yard specified in the contract. The court then had to determine whether the vessel delivered was so identifiable. That is to say, the question became ‘simply whether, as a matter of fact, it [could] fairly be said that – as a means of identification – the vessel was Yard No. 354 at Osaka Zosen or “built by Osaka Shipping Co. Ltd. and known as Hull No. 354 until named”’.Footnote 136
The third type of case commonly necessitating categorisation or classification is where a contract term includes a technical word or phrase or a complex concept, whether it be legal, scientific or based on a custom or trade.Footnote 137 If the word or phrase bears a complex or technical meaning, the court may need to categorise or classify the facts in a sophisticated way so as to apply the contract. ‘Force majeure’ clauses are a simple example.Footnote 138 Clauses excluding liability for ‘consequential’ or ‘indirect’ loss are a more prominent illustration. In some cases, the question of application is straightforward because the contract defines what amounts to ‘consequential’ or ‘indirect’ lossFootnote 139 or it is clear from the contract as a whole that the phrase should bear a particular meaning.Footnote 140 However, in other cases, English courts have construed such clauses, in light of the test for remoteness of loss,Footnote 141 as not excluding liability if it naturally arises from the breach in question.Footnote 142 This leaves significant work to be done in categorising the facts so as to establish whether the loss is excluded.Footnote 143
The fourth situation often giving rise to complex reasoning in terms of categorisation or classification is where a term contains a causation element or link. This problem commonly arises in the construction of insurance policies and commercial indemnities and releases. For example, policies of insurance often contain a range of causation elements,Footnote 144 including with respect to whether a particular loss or injury was caused during the policy period or caused by a particular factor or factorsFootnote 145 and whether liability is excluded from cover because it arises out of, or was based on, or was brought about by, a particular occurrence.Footnote 146 Commercial indemnities and releases also contain similarly complex causation links.Footnote 147 Of course, the causation test may be clarified through interpretation.Footnote 148 However, the test that results often still requires the resolution of difficult causation questions, such as whether a particular cause is a ‘proximate cause’ under an insurance policyFootnote 149 or whether a cause is an ‘effective cause’ under an indemnity.Footnote 150 These types of cases do not depend ‘to any great extent on matters of linguistic meaning and how the words used would be understood by an ordinary member of the public’; what is in issue is ‘the legal effect of [the contract], as applied to a particular factual situation’.Footnote 151 That is to say, these cases turn on categorising or classifying the facts rather than any search for objective intention.
The fifth scenario frequently necessitating classification or categorisation in complex terms is where a contract term needs to be applied to unforeseen circumstances. Sedley LJ described the problem in Casson v Ostley PJ Ltd:Footnote 152
[T]he parties have simply and understandably not even thought about the event which has now caused a problem … and the courts have only the now insufficient words on the page to fall back on.Footnote 153
Of course, even in this situation, the relevant term is often construed such that it is clear how it should be applied to the facts.Footnote 154
The sixth type of case commonly giving rise to the need to classify or categorise facts in a rigorous and detailed way is where the court must define a contract term broadly so as to accord with the objective intention of the parties. For example, in The Antaios,Footnote 155 a termination clause providing a power to terminate for ‘any breach’ was construed such that it only gave rise to a power to terminate for ‘repudiatory breach’.Footnote 156 Adopting this approach, the breach in question had to be classified to determine whether it was ‘repudiatory’.
It is these types of cases that necessitate complex reasoning in terms of categorisation or classification; it is these types of cases where the application process is engaged in a meaningful way. One resorts to categorisation or classification only after attempts to define the relevant term with further precision have failed. Of course, some judges and lawyers may be inclined to draw more from objective meaning or intention than others, and vice versa, such that a question resolved by some as a matter of interpretation is resolved by others as a matter of categorisation.Footnote 157 Critically, what ultimately distinguishes the process of application from the process of interpretation is that the latter is guided by the pursuit of objective intention or meaning in defining the relevant term, whereas the former is rooted in the categorisation or classification of the facts.
Conclusion
This paper has sought to bring some clarity to what is involved in the application of contracts by defining the process in terms of its objects, its mechanics and its use in practice. In essence, contract application is a process through which one classifies or categorises facts to establish whether the components of a contract term are met. There of course remain lingering uncertainties regarding the process. Three are worthy of particular mention.
The first is whether the application of a contract term is properly to be characterised as a question of law or a question of fact. This is obviously important in the context of appeals.Footnote 158 The interpretation of a wholly written contract is said to involve a question of law.Footnote 159 Perhaps due to the close connection between interpretation and application, questions of application (at least in the case of contracts reduced to writing) have been addressed in a similar way on appellate review.Footnote 160 That said, the characterisation of questions of application as questions of law may not simply be a matter of the close connection between interpretation and application. If the process of application is understood as one of categorisation or classification, it is arguably proper to regard questions of application as questions of law. One engages in a factual enquiry by ascertaining the facts to which the contract is to be applied. But then one resolves a question of law (at least in the case of wholly written contracts) by determining whether the components of the relevant contract term are satisfied on those facts.
The second point of uncertainty is related: to what extent does precedent impact the application process? Precedent is often said to play a limited role in the interpretation of contracts.Footnote 161 For example, it may only be relevant if the language and context are the same,Footnote 162 if the meaning is settled,Footnote 163 or in the case of a contract using standard language, such as a building and construction contract.Footnote 164 In contract application, the role of precedent appears to be similarly limited. It plays a role in categorisation by analogy with past cases.Footnote 165 And it may impact categorisation by criteriaFootnote 166 and factor-balancingFootnote 167 in so far as prior authority indicates relevant criteria or factors, as the case may be.
The third and perhaps most critical issue with the way in which contract application is understood in this paper relates to its limited role in practice. When faced with linguistic indeterminacy in a contract dispute, one often has two choices: interpret and define the term so as to resolve the problem; or categorise the facts to determine the dispute. As this paper has demonstrated, courts tend to resolve such problems by stretching meaning and intention through interpretation, rather than by categorising or classifying facts as a matter of application. One might reasonably wonder why this is the case. A perhaps superficial answer is based on the notion that the cornerstone of the common law of contract is the principle of freedom of contract – ‘the idea that the content of the parties’ contractual obligations is a matter of choice for the parties, rather than imposed by the law’.Footnote 168 So as to further freedom of contract, to the extent possible, courts should resolve problems of linguistic indeterminacy by reference to the objective intentions of the parties, even if by inference. The difficulty with this justification is that, if the basis for inferring party intention is tenuous and unconvincing, it is hard to see how such an approach actually advances freedom of contract. Objective intention and linguistic meaning are not necessarily more certain tools than categorisation and classification.
It may be that courts are reluctant to embrace categorisation or classification as a means to resolve linguistic indeterminacy because of the view that words do not have acontextual meanings. That is to say, for some, words ‘do not have a “meaning” of their own’; ‘[t]hey do not have a “meaning” independently of the person who utters them or the person who hears them’.Footnote 169 On this view of meaning, contract application is guided by objective intention. Any criteria or properties of a component of a contract term, or factors that bear upon establishing whether a component is satisfied, are established as a matter of objective intention: what the parties objectively intended by the words. However, this position denies the concept of semantic autonomy, that is, the notion that words ‘carry meaning independent of the communicative goals on particular occasions of the users of those symbols’.Footnote 170 At a basic level, words must have objectively-identifiable abstract meanings in order for communication to be effective.Footnote 171 Without a shared understanding of such meanings between audience and speaker, an audience cannot understand what a speaker says.Footnote 172 On one view, it is by tapping into this common reservoir of objectively-identifiable abstract meanings that one categorises or classifies in applying a contract; it is how one identifies the criteria, factors or points of comparison that bear on the application process.
Further study of how we categorise or classify facts to apply a contract is certainly warranted. It may assist in understanding why judges and lawyers tend to interpret away problems of linguistic indeterminacy rather than deal with them through categorisation or classification. Indeed, further investigation in this area presents a range of potential benefits. Outside of doctrinal legal studies, it may assist in research analysing how we can automate legal reasoning. Beyond contract, it may help enhance our understanding of how statutes and other written instruments are applied. Focusing solely on contracts, it may result in a greater inclination amongst judges and lawyers to resort to categorisation or classification, at least in a more overt manner. It may mean that problems of linguistic indeterminacy that are currently resolved as a matter of intention can actually be resolved by classification. With development, the application process may offer a more certain and logical basis upon which to resolve such cases than a tenuous determination that the contract means X or the contract means Y. Time will tell. In the meantime, those faced with cases of linguistic indeterminacy (where intention and meaning do not readily present an answer) should consider whether classification by criteria, factor-balancing or analogy is appropriate. Each basis for classification has a robust foundation in legal jurisprudence and more broadly in linguistics, mathematics and philosophy. This foundation may provide the cognitive framework necessary to categorise rather than interpret.
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